52 Pages Posted: 19 Jun 2004
Date Written: July 1991
This paper studies career concerns -- concerns about the effects of current performance on future compensation -- and describes how optimal incentive contracts are affected when career concerns are taken into account. Career concerns arise frequently: they occur whenever the market uses a worker's current output to update its belief about the worker's ability and competition then forces future wages (or wage contracts) to reflect these updated beliefs. Career concerns are stronger when a worker is further from retirement, because a longer prospective career increases the return to changing the market's belief. In the presence of career concerns, the optimal compensation contract optimizes total incentives -- the combination of the implicit incentives from career concerns and the explicit incentives from the compensation contract. Thus, the explicit incentives from the optimal compensation contract should be strongest when a worker is close to retirement. We find empirical support for this prediction in the relation between chief-executive compensation and stock-market performance.
Suggested Citation: Suggested Citation
Gibbons, Robert S. and Murphy, Kevin J., Optimal Incentive Contracts in the Presence of Career Concerns: Theory and Evidence (July 1991). NBER Working Paper No. w3792. Available at SSRN: https://ssrn.com/abstract=420290